Previous Test

36.4 Lessons learnt

What have we learnt?

Implied volatility 

 

  • The implied volatility estimates the future volatility, whereas historical volatility looks backward – don’t mix them!
  • Being an essential component of the time value, you need to be aware of the impact of an increasing and decreasing implied volatility;
  • If you buy options with high implied volatility, the markets expect more significant price movement, and you pay for that.
  • If you think the underlying value will not move as much as the market expects, you can consider selling options.

Standard deviation 

  • As you can see, many elements influence the price of an option. As you have learned, these are the most important ones:
  • Dividend
  • Interest
  • Underlying value
  • Volatility
  • Duration
  • Strike price
  •  

Standard deviation is a measure of dispersion around a mean value.

  • We use underlying forward price and option information to calculate a mean value and standard deviation.
  • We can create a probability distribution using the standard deviation and mean value.
  • We calculate the area under a probability distribution in a given range to calculate probabilities.
  • The standard deviation increases when the volatility increases (all other things being equal).
  • When the days to expiration increase, the standard deviation increases (all other things being equal).
  • When the standard deviation increases, a strike price is theoretically more likely to expire in the money (all other things being equal).